English Right of Set-Off Term Paper

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And, according to the Court of Appeals, claims that are merely contingent at the relevant date, but are not "due" are not employed in a set-off.

The right of combination differs from the right of set-off because, unlike set-off which assumes independent obligations between parties, combination allows full balancing of all liabilities. Unless there is an express or implied agreement to keep accounts separate, even accounts that are different in nature have been considered to be automatically combined in determining the final balance upon insolvency. The cases do not seem to offer a perfectly predictable rule, but generally there is an implied agreement that a loan account in debit and a current account in credit should be treated as separate. Unlike the right of set-off, the right to combine an account belongs only to banks. A bank may treat accounts kept at separate banks as combined, but a customer may not, for example, overdraw funds from one account claiming that funds from another account can cover it.

Basically, the insolvency of the customer is not as big of a concern for banks, in this system, because the process of going after the customer for repayment is made easier by the granting of the right. But conversely, the insolvency of the bank has grave consequences for a customer, because the customer may have severely limited abilities to recover deposits from an insolvent bank and is subject to great losses from its inability to combine accounts of loan and credit.

The English bankruptcy statute requires an account to be taken before set-off occurs. In Stein v. Blake, a plaintiff, who would soon be adjudicated bankrupt, brought claims for contractual breach against the defendant, who then counterclaimed for misrepresentation. The trustee in bankruptcy assigned the claim that the defendant had broken an agreement with the plaintiff to equalize his shareholding in various companies against the defendant to the plaintiff. The assignment was made with the intention that any proceeds recovered by the plaintiff would be split with the trustee. The judge stayed the action as the defendant asked. The higher court held that since the object of a set-off in bankruptcy was to do substantial justice between the parties "all mutual and commensurable claims are to be set off": a trustee in bankruptcy could assign the bankrupt's claims against the person entitled to exercise the right of set off so that the bankrupt's action against the creditor could be restored. The trustee in bankruptcy in not required to take the account nor prevented from assigning a cause of action.

The court reasoned that, "The language of the section draws a distinction between what is due- which is the word used in subsections (2) and (3) and what is payable or recoverable... The separate causes of action (claim and cross-claim) remain due, and do not cease to exist, until the set-off has been completed by payment one way or the other." The court went on to say, "It is also noteworthy that the section does not provide that only the trustee in bankruptcy may take the account: subsection (2) only states that 'an account shall be taken'" (emphasis added). Thus, some authority must realize and distribute an insolvent party's estate, but it does not prohibit the trustee from assigning a cause of action that is part of the estate and it doesn't require the trustee, rather than a bankruptcy judge to take the account.

In National Westminster Bank Ltd. V. Halesowen Presswork & Assemblies, the parties had agreed that the bank would freeze Halesowen's overdrawn account ("account 1"). They had agreed to keep a newly opened account in credit (account 2) without being able to claim a set off on the credit balance against the debit balance on the frozen account for a period of four months. During that period, the company gave notice of a creditors' meeting at which they resolved to voluntarily wind up.

The court reasoned that the debits on the first account and the credit on the second account amounted to "mutual credits, mutual debits or other mutual dealings." It held that set-off is mandatory and that parties cannot contract out of it, noting in passing that the Supreme Court of British Guiana had held that it was in fact possible to contract out of the statutory obligation to set off. It reasoned that in the agreement the bank had merely agreed not to try to secure payment of the amount the insolvent company owed them for four months unless there was a material change of circumstance, but that the agreement did not contemplate what course of action to follow in the event of the company's liquidation.

In a concurring opinion in Halesowen, it was remarked that, commonly, "mutual dealings" does not cover a transaction in which property is made over for a 'special' or 'specific' purpose. The justice wrote that Every payment of money, every contractual provision, is for a special or specific purpose in the ordinary sense of those words; something more is required to take the transaction out of the concept of 'mutual dealings.'... [M]oney is paid for a special or specific purpose so as to exclude mutuality of dealing within s 31 if the money is paid in such circumstances that it would be a misappropriation to use it for any other purpose than that for which it is paid."

The court in earlier cases had held that a special purpose could be found: where a solicitor held money entrusted to him by the bankrupt for future costs; where a solicitor held a surplus out a sum specially provided by the bankrupts for the satisfaction of pre-bankruptcy claims; where a fund was held as a guarantee against the carrying out of specific obligations. One Halesowen opinion remarked that in those cases, the funds had been given marked as intended as a quasi-trust, which destroyed mutuality in that the "right" involved was different.

As one opinion seems to suggest, it is not clear why, as a matter of social policy, two parties cannot agree to contract out of the right of set-off with a view to impending insolvency or bankruptcy. All that the Halesowen opinions focus on is the fact that the agreement didn't seem to contemplate what would happen in the event of a winding-up; the opinions don't offer concrete reasons why the right of set-off and combination is so important that two parties cannot consensually determine it will not be exercised. One could argue it is important because ultimately only the directors of a company really know how well it is doing and banks cannot be expected to check up on the financial status of every company to which they loan money. But, this is farfetched. The truth is that banks should check on financial status before loaning money or before entering into agreements. The right of set-off and combination greatly decrease the risk a bank takes in giving out a loan, and does encourage a bank to give loans to enterprises. Certainly, this is good for business. However, the overwhelming power of the right simultaneously diminishes the contractual freedom of companies and allocates an unusual amount of risk to customers in the banker-customer relationship. The decision makes it financially important for customers to keep accounts at multiple banks, rather than opening multiple accounts at one bank. Unfortunately, this means a lot more work in accounting for customers, especially because set-off operates as a defense only and may not be initiated by the debtor (even, apparently, a bank is likely to be unable to repay a security to a guarantor). If a customer becomes insolvent, the bank is free to combine accounts to avoid loss. If, however, a bank becomes insolvent, the customer is not similarly positioned to recoup the losses it incurred in trusting the bank with deposits. The following cases particularly illustrate that principle.

In Re Bank of Credit and Commerce International [1994] 3 All ER 565, a bank's loan to a company was secured by a third party's grant of a charge over his funds which were on deposit at the bank. The bank itself went into liquidation prior to repayment. The liquidators asked the court whether they should try to recover the full amount of each outstanding loan from the company, leaving the third party to prove in liquidation for the deposits charged to the bank.

The company and third party depositer argued that the liquidators should only get the extra over the amounts deposited claiming a right of set off. The court held that in such a situation there could be no set-off of the deposit against the amount owing by the company since the documentation did not make any of the principal debts due from the depositors. Consequently the depositers were left to prove for their deposits in liquidation of the bank, although up to that time the depositers had been unable to withdraw…
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